Is the Federal Reserve caving in to political pressure against further monetary easing?
Some analysts say the Fed, an institution that prides itself on independence, has been swayed by critics at home and abroad. Others say the central bank is simply holding fire on further easing until it sees how current efforts pan out.
Minutes from the central bank's January meeting contained new forecasts from top policymakers showing most believe the central bank will fall short of both its price stability and full employment mandates well into next year.
Yet rather than talking about doing more, the Fed appears to have set a really high bar for any bond purchases beyond the $600 billion announced in November, the second round of quantitative easing that became popularly known as QE2.
Vocal opposition to that plan caught Fed officials by surprise, raising concern that the policy could take an unanticipated toll on the central bank's inflation-fighting credibility -- key to confidence in any monetary authority.
Loud criticisms also came from overseas policymakers, who accused the United States of a beggar-thy-neighbor strategy of driving down the dollar to boost exports.
Now, with the economy showing renewed vigor including some glimmers of hope on employment, the Fed appears to have all but given up on further easing steps.
Even officials like Charles Evans, the dovish president of the Chicago Fed who back in October was calling for aggressive action by the central bank, appeared to be dialing back.
"It will not surprise me if at the time we get to June and we are looking at the economy, that things are sufficiently better that that might be enough," Evans told reporters after a speech on Thursday.
Data released on Thursday showed the biggest spike in core consumer prices in 15 months in January, suggesting inflation may have bottomed. Richard Fisher, president of the Dallas Fed, cited evidence of upward price pressures in a speech on Thursday.
Still, core inflation compared to one year earlier was still 1 percent -- far below the Fed's presumed comfort range of 2% or a bit below. Policymakers' own "central tendency" forecasts see their favored core inflation measure, the core PCE, staying between 1% and 1.5% through the end of 2010.
At the same time, the jobless rate remains at 9%, though it has come down rapidly over the last two months.
Against that backdrop, analysts say politics has to be playing some role in the Fed's reluctance to entertain further easing options. Even if the Fed is not explicitly reacting to political influence, the opposition certainly appears to be affecting the cost-benefit analysis of policy.
"The political opposition to QE2, both inside and outside the U.S., would give the Fed pause about adopting further increases in the Fed's balance sheet beyond those already announced," said James Hamilton, professor of economics at the University of California, San Diego.
QE2 AND THROUGH?
Set to be completed at the end of the second quarter, the Fed's bond-buying program appears to have had a positive effect on stock prices. Still, economists disagree about the likely impact on economic growth.
Janet Yellen, the Fed's influential vice chair, has argued that the latest round purchases will translate into 700,000 new jobs, with the entire $2.3 trillion asset purchase program contributing to the creation of as many as 3 million jobs.
Private sector economists are more conservative. Lawrence Meyer, a former Fed governor now at the consultancy Macroeconomic Advisors, believes Fed asset buys raised the level of gross domestic product by between 1.5-3 percentage points over eight quarters. That, he says, would be consistent with new jobs for between 1.5 million and 3 million Americans.
That effect is hardly unsubstantial, and begs the question of why the central bank would be reluctant to do more.
One possible answer could be timing. The Fed has little to gain by jumping the gun and talking about future measures when it has yet to reach the halfway-mark for its existing bond-buying commitments.
"It's just too soon to get into that discussion," said Steve Blitz, senior economist at ITG. "And to say that you're going to need to do it again, you're sort of saying it's not working. So I think they'd rather wait till they meet in May to discuss in earnest what they are going to do."
Still, if the committee envisions the need for further measures, they might like to begin laying the groundwork for it sooner rather than later. QE2 was widely telegraphed to financial markets months before it was put into place.
Another explanation for any delay of QE3 talk is recent concern in financial markets about the possibility that the Fed might be exposed to losses on its massive bond portfolio, something that could make it even more vulnerable to political intervention.
Joseph Gagnon, a former Fed economist now at the Peterson Institute for International Economics refers to this as a worry about the "delayed political consequences from the risk of future losses on their balance sheet."
He says that if the Fed were to strictly follow its implicit target for inflation of 2% or a bit below, it should be doing more, not less.
"All measures of core inflation are at record lows and that is what they focus on," Gagnon said.